The unavoidable global tax problem

Tax is a dry subject. It may be one of the certainties in life, but it is extremely complex, few fully understand it, and most individuals feel they pay too much of it. But therein lies a problem. Some large corporations are paying way too little tax. The Economist has referred to tax dodging as the 'missing $20 trillion'.

As such, there is likely to be a lot of talk about combating tax avoidance in the G8 and G20 meetings this year and next. Prime Minister Cameron has signaled that as chair of the G8 in 2013 he will be calling for bold action on tax evasion. He has support from Chancellor Merkel, who said: 'It is not right that giant global companies have huge sales here (in Germany), in all of Europe, in the US and elsewhere and only then pay taxes somewhere in a tax haven'.

Prime Minister Gillard said this issue should find a 'fruitful agenda' in the G20 and that Australia would use its position as chair in 2014 to get it addressed. Treasurer Swan wrote to G20 Finance Ministers prior to their meeting in Moscow last week calling for a global action plan to combat international profit shifting and tax avoidance.

Tax may be eye glazing stuff, but coffee drinkers in the UK boycotted Starbucks when it was revealed that the company was paying minimal tax. The apparent injustice was that much more intense since the majority of UK citizens were facing higher taxes and reduced public services as the UK battled its debt woes. It was just not fair.

The problem is described as 'base erosion and profit shifting'. In short, companies shift profits to low tax jurisdictions. They engage in so called 'transfer pricing', where profits are shifted within controlled or related companies. They also take advantage of inconsistencies in agreements designed to avoid double taxation. And there are still many tax havens with the welcome mat out for these mobile profits.

A major problem is that the tax laws have not kept up with a globalised world and technology, particularly e-commerce. In such a world it is difficult to determine exactly where a transaction takes place in order to tax it.

The OECD presented a report to the Moscow G20 Finance Ministers meeting on 'addressing base erosion and profit shifting'. It called for a 'comprehensive solution' involving all stakeholders. The G20 Finance Ministers said that 'we will take necessary collective actions and look forward to the comprehensive action plan the OECD will present to us in July'.

This is an area where the G20 can add value. It requires collective action because it cannot be solved by one country alone. When Prime Minister Cameron announced his assault on base erosion and profit shifting, UK firms said that 'standards need to be developed, applied and enforced on a global basis to avoid the risk of regulatory arbitrage which will almost certainly disadvantage UK and EU companies'.

Consistent collective action is the antidote to regulatory arbitrage. Though the difficulty of the task should not be underestimated, this is an issue where the G20 can add real value. It cannot be addressed solely in the G8.

To the extent that 'base erosion and profit shifting' can be reduced, the beneficiaries will be citizens in all countries. It may be eye glazing stuff to most, but it is important to all.